Confused About the 1099-C Form?
Are you considering filing for insolvency but unsure if you completely qualify?
Every year many businesses and individuals miss out an opportunity to file for insolvency because they don’t know about it, while others file incorrectly because they don’t understand it.
Here at Silver Tax Group our team handles cases like this every day–and we love answering your questions.
Keep reading for more information about insolvency and how you can claim it correctly.
Insolvency vs. Bankruptcy
Let’s put it this way: Unaddressed insolvency leads to bankruptcy, but you can be insolvent without being bankrupt.
Bankruptcy is a legal process that resolves debts with court oversight, whereas insolvency is a tax code term that indicates one qualifies for certain income tax benefits.
When you declare bankruptcy a court may extinguish some (or all) of your debts, or they may restructure those debts as they deem fit. When you are insolvent it means you have reached an agreement with your creditors that you cannot pay back some or all of your debt and that you are not required to pay some or all of the taxes on that forgiven amount.
The IRS and Cancelled Debts
To understand insolvency you need to understand that the IRS tends to collect taxes on canceled debts. According to the IRS official website:
In general, if you have cancellation of debt income because your debt is canceled, forgiven, or discharged for less than the amount you must pay, the amount of the canceled debt is taxable and you must report the canceled debt on your tax return for the year the cancellation occurs.
Say you owed $5,000 to a creditor but you were able to cancel that debt. The IRS sees this as income. For taxpayers in the 35% tax bracket the IRS could charge up to $1,750 in income taxes on that canceled $5,000 debt.
But for you that canceled debt probably does not feel like added income. It’s likely that you cannot pay that debt because neither your assets nor your cash flow allow for full repayment.
Luckily, the IRS offers you a way to establish this.
The Insolvency Formula
The formula is very simple. Making sure you’ve got it right isn’t always so easy.
Insolvency is just your assets minus your liabilities.
To know exactly what your assets are worth all together you need to understand the market value of everything you own. If everything you own as well as the amount of cash and funds under your name all added together are still less than your liabilities, you are technically insolvent.
However, even though plenty of people qualify, far too few actually file for insolvency and use this status to help themselves out come tax season.
Cash-Flow Insolvency
Cash-flow insolvency refers to the inability to pay back a debt because the money just literally isn’t there. For instance, you owe money for a credit card bill, but you don’t have the money.
It goes a bit further though; to be truly insolvent in this situation it means that you literally do not have anything left to sell that could get you the money you need. Furthermore, you are not able to borrow any money or take out any more lines of credit.
Balance-Sheet Insolvency
A business can take a look at its assets, inflows, and outflows and see whether or not it is profitable or unprofitable.
If your business is in the red you might be considering filing for bankruptcy or insolvency. To be truly insolvent in this situation your assets need to be worth less than your debts — or in other words, even if you sold the things your business owns, like vehicles or properties or stock market shares, it still wouldn’t cover the debt that is owed.
It is not uncommon for businesses to technically be balance-sheet insolvent but still be able to pay monthly bills due to cash-flow revenues.
Tackling the 1099-C Form
The 1099-C form is the Cancellation of Debt form.
You are going to receive this form if a creditor is willing to “write off” the remaining portion of your debt (or all of it). Creditors file this form with the IRS when they have reached a settlement with you, or if they determine that your debt just isn’t going to be paid.
If the debt is $600 or over then the creditor must send you, the debtor, a 1099-C form in the mail by January 31st of the tax year in which the debt was discharged; they must file it with IRS by February 28th of that same year.
The 1099-C offers you a few different debt-cancellation options; this offers you a way out of reporting your canceled debt as income. Insolvency is one of these options. You can also list bankruptcy on this form, but do not do that unless you have already gotten the debt discharged through a proper bankruptcy proceeding.
It’s Not Just That 1099!
You are also going to have to fill out the IRS Form 982! Don’t worry, the IRS Publication 4681 is designed to help you out, so make sure to take a look at that.
Is Insolvency Right For Me?
Here’s the deal: if you can pay your debt, you should. Say you find a way to cancel or compromise on your debt via insolvency and then the IRS finds out that you actually do have some assets that you tried to hide? Now you’re in trouble and could face fines.
Insolvency is a way of telling the IRS “this debt has been canceled, but please don’t consider it added income. Look, I’m unable to pay it back with my cash flow and my assets!”
So, for many people who have been able to compromise or cancel their debts, insolvency is a very useful and often underutilized option.
However, every case is unique, and you really need to consult a trusted tax professional before being 100% confident moving forward.
What Else Should I Know?
You cannot claim you did not receive the 1099-C in the mail. You should reach out to your creditor and ask them to send it if you haven’t received it yet.
Your debt cancellation might move you into a higher tax bracket, which makes the 1099-C even more important for saving money!
Your creditor may have sold your debt to a third party collection agency or it could be taken over by a parent company, so the name on the 1099-C form might seem unfamiliar. You can always make a call to clear things up.
Reach Out to a Qualified Professional
Still have questions?
Handling complicated tax issues on your own can be intimidating — and rightly so! Trying to handle it all yourself means that you don’t know if you are saving money or losing it — and believe us, every year millions of people are losing money.
Here at Silver Tax Group it’s our job to know the ins and outs of the tax code so that you don’t have to. We can help find ways to solve your problems and save you money. Don’t negotiate with IRS on your own, let us help you!
